Know Your Odds Before You Trade By Lawrence Chan Second Edition potx

Know Your Odds Before You Trade
By Lawrence Chan
Second Edition, April 2012
Copyright Lawrence Chan 2010-2012
Smashwords Edition License Notes:
Permission is given to copy, distribute, repost, reprint, and share this free eBook provided it
is presented in its entirety without alteration and the reader is not charged to access it.
Also by Lawrence Chan, available now and soon at ebook retailers everywhere:
Special Theory of Price Discovery
Market Bias Detective: S&P 500 Daytrading Time Map Vol. 1 & 2
Market Bias Detective: ForexDaytrading Time Map Vol. 1
Market Bias Observer Newsletter
~~~~
Disclaimer
Limit of Liability / Disclaimer of Warranty: While the author and the publisher have used their
best efforts in preparing this book, they make no representations or warranties with respect
to the accuracy or completeness of the contents of this book and specifically disclaim any
implied warranties of merchantability or fitness for a particular purpose. No warranty may be
created or extended by sales representatives or written sales materials. The advice and
strategies contained herein may not be suitable for your situation. You should consult with a
professional where appropriate. Neither the publisher nor author shall be liable for any loss of
profit or any other commercial damages, including but not limited to special, incidental,
consequential, or other damages.
CFTC RULE 4.41 – HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN
LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT
REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE
RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN
MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL
ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT.
NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE
PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.

~~~~
Preface
Second Edition
Many readers who read the first edition of this book told me that they recommended this
book to their friends and loved ones either troubled by trading, or interested in trying out
their hands on trading. Many of these individuals have no clue of what they are getting into.
Somehow my way in relating the subject gets the message through to these individuals even
though prior attempts by others have not produced results. I am told that positive changes
happened to many of them. If you find it difficult to discuss the issues raised by this book
with someone you care about, you can recommend this book to them. Sometimes it is easier
for a stranger to bring the bad news.
Lawrence Chan
Toronto, April 2012
First Edition
I have been asked this question way too many times, "How do you beat the market?" Back in
the 1990s when I first started out trading on the TSE floor, I was too young and green to give
an answer because I was just learning how to trade myself. I wasn’t even qualified to answer
the question.
When I started trading off the floor, the stressful trading style had such a bad effect on my
temper that I never gave the proper answers.
Over the years, after having helped many struggling traders, I have come to understand why
people ask the question, but the answer is not something that can be delivered in a sentence
or two.
This short eBook is my sincere answer to this big question. Hopefully, this eBook can help
many traders find the answers they need to either stop trading for good or to form a
comprehensive plan to overcome their obstacles in trading, and eventually turn the tides in
favour of becoming consistently profitable.
As opposed to using mathematical formulas or trading systems as the foundation for the
arguments, I have chosen a common-sense approach to explain many of the concepts
presented in this book. My intention is to help traders, including those who just starting out,

to understand the subject better before it is too late.
Lawrence Chan
Toronto, August 2010
~~~~
Table of Contents
Preface
Second Edition
First Edition
Introduction
Odds in Trading
What Kind of Odds Are We Talking About Here?
Odds of Your Particular Trade Being Profitable
Odds of Your Trading Account Being Ruined
Odds of a Retail Trader Being Able to Self-Correct
Odds of a Retail Trader Mastering the Art of Trading
Beating the Odds
Practical Success for Retail Traders
Not Everyone Has an Equal Start
Accepting the Fact That You are Fighting an Uphill Battle
Have a Proper Battle Plan When You Fight a War
Patience Is a Virtue
Equip Yourself with Knowledge on All Aspects Related to Trading
Understanding the Importance of Capital Preservation
Searching for Your Own Trading Style
There Is No Need to Trade Full Time
There Are Times You Should Simply Stop Trading
Too Much Positive Thinking Is Hazardous to Your Bottom Line
Afterword
Know Thyself
Trading Skills Are Useful Outside of Trading

Resources for Aspiring Traders
Acknowledgements
About Lawrence Chan
~~~~
Introduction
To know your odds before you trade is one of the most (if not the most) important concepts
that enables a retail trader to survive long enough to acquire the necessary elements needed
to achieve trading success in the financial markets. The lesser known fact is that it is equally
applicable to any form of risk taking, like buying or selling real estate or running a business.
One of the major weaknesses we have as human beings is our inability to properly evaluate
various kinds of risk. We may know that getting too close to a lion that is roaming around
freely is dangerous. Yet most of us do not understand that the risk of putting our lifelong
savings into various trading vehicles is so high that it can ruin our lives in ways we could never
imagine.
Many people think that they are not trading but are just investing for the long term. That is
very much like telling people you are a vegetarian because you only eat chips and drink sodas.
These people often call themselves retail investors, a term that makes them feel much better
and that gives them an excuse to not learn how to trade properly. Hence, these individuals
facie a similar (if not higher) risk of losing all their life savings just like the average person
who gambles at the casino addictively.
The intention of this book is to introduce retail traders (and investors alike) to the concept of
risk and to help them understand their odds of being able to make money from the markets.
When investors can recognize the risk involved and understand how the odds are in favour of
their failure, only then can they be called an informed trader (or investor) who knows how to
trade within the risk that he/she can tolerate.
Many trading education books touch on this subject and what I have to say is not something
totally new. But no one, in the hope of selling their books, would spend all their efforts on
what I am doing here — attempting to convince people to take trading slowly and seriously,
explaining in painful detail why they will fail if they don’t. Those who listen carefully and do
what is necessary stand a better chance at developing into consistently profitable traders.

Hidden in the odds against the traders are clear pathways to success once the traders realize
what it takes to beat the odds. The road to consistent profitability is long and rocky, because
we are humans and not machines. Whether we like it or not, we are going to be subjected to
emotional influences from the outcomes of trading and other unpredictable events.
I do believe, however, given time and proper guidance, most people can achieve a reasonable
level of consistency in their trading success.
Throughout this book I use the word trader interchangeably with the word investor.
~~~~
Odds in Trading
Odds, by definition, is the likelihood of one thing occurring more so than another.
For example, what do we mean when we say that the odds are that it will rain today? It
implies that it is more likely going to rain than not rain today. Notice that we skip the other
event (not raining) in the first sentence because there are two possible outcomes in this
example: to rain or not to rain. This means that if the odds favour that it will rain, then it is
implied that the odds of it not raining are less likely.
In trading, however, there can be many outcomes to any given trading position. The trading
position you are holding by the time you close out the trade can have many outcomes. It may
make a big killing, make good profit, make a tiny profit, not make any money, lose some
money, lose big money, or lose more than what is in your trading account. This is the first
important fact to remember.
As you can see, the odds in trading are complex. There are many factors that affect the
outcome of each trade, and accumulatively, on the net profit or loss made by the person
throughout his or her life time. Yet most people I encounter think of trading as a one-time
event, and that one-time event has only two outcomes — they are either right or they are
wrong. By oversimplifying the matter at hand, or, maybe being misled into believing that
trading is such a simple thing, the odds of these folks making money from the markets over
their lifetime are pretty low.
What Kind of Odds Are We Talking About Here?
There are many kinds of odds that we can use to describe trading. Here are four that I cover
in this book:

• Odds of your particular trade being profitable
• Odds of your trading account being ruined
• Odds of a retail trader being able to self-correct
• Odds of a retail trader mastering the art of trading
And don't forget that in life there are many other things that can affect the outcome of your
trading. We will spend some time on how to minimize the impacts of events that can affect
your trading adversely. Are you thinking that I am wasting your time already?
Here is a good example of what I mean. You have just closed a trade that is potentially very
profitable, and at the exact moment that you are entering your order on your computer, you
are disconnected from your broker on the Internet. How does that sound to you?
Now, I am going to explain each of the odds listed above in detail.
Odds of Your Particular Trade Being Profitable
There are many ways to identify a trading opportunity. There is absolutely no fixed rule on
what or how a trade is entered. As long as you have done your homework in identifying a
trading setup, and you are willing to pull the trigger, you will be sitting on a position. By the
time you close your position, the trade is completed.
Just how likely it is that you are going to be profitable on a particular trade depends on many
factors. This is not something we can tell precisely. However, we can tell easily if the odds
are reduced.
With less than your ideal state of mind in making your trading decisions, odds of the trade
being profitable is lowered.
Before entering a trade, there are three elements that can hel p you trade calmly and free of
stress. These are knowing exactly what type of risk you are getting into (e.g., using stop
orders properly); having a full understanding of the winning probability of such a trade based
on the reasoning that gets you into the trade in the first place (e.g., historically how the
scenario is likely to unfold, tips you get from a secret source); and knowing that in the worst
case scenario this one single trade would not affect your ability to carry on your life or your
ability to take the next trade.
Anything less than this will make you nervous as the trade develops, introduce mistakes into
your decision making, and turn a perfectly good trade into a disaster. I am not talking about

being completely numb to the risk that is being taken or not feeling any tension or
excitement at all. I am talking about keeping your mind focused on the trade so that you can
make sound judgments when they are needed the most.
Here is an example. If you have a reasonably stable income and your household cash flow is
positive, then buying a lottery ticket is not going to make you lose sleep over the fact that
the money you paid for the ticket is very likely to be as good as burned into ashes already.
But, if you throw in your life savings into buying all the tickets you can buy, then you are very
likely going to feel extremely bad should the tickets not produce enough winnings to cover
the cost.
A confused plan, without proper preparation of your mind to handle the unavoidable losing
streak, is another factor that can lower your odds of being profitable in a trade.
A perfectly executed trade can be a losing trade. There is nothing wrong with that IF you
already know the exact odds of the potential outcomes. Not accepting the losing side of the
potential outcomes of your trades will encourage you to keep looking for the Holy Grail that
will improve your trading. The reality is that you have nothing you can improve because you
do not have the correct perspective that can help you improve.
Trading in a market that is too risky for your tolerance level will lower the odds of your trade
being profitable.
Retail traders do not have the infrastructure of a trading firm to support them or the financial
support that is much needed to develop their trading abilities. They do not have an advisor to
talk to or a friend to talk to who can understand what they are going through. Most of the
money that retail traders put into their trading accounts is hard-earned money, making it
extra painful to see how easy and quickly the money can be burnt. Thus, the issue of a single
trade going badly and having a negative outcome is especially problematic for retail traders.
Most people do not understand their own risk tolerance level. Period. It is not a function that
only depends on the person’s net worth or how much burnable money there is in the trading
account. It is much more related to the personality and character of the trader. Some people
think that if they have more money in their trading accounts they would do better. The truth
is that a bigger bank roll does not change a person's risk tolerance overnight. If you are one of
those people who have a very low risk tolerance, then even trading on the smallest possible

size in some markets will paralyze you on the first losing trade, causing you to function badly
when called on to make any sound judgments. There are also people who pretend that they
have high risk tolerance. This is only good for showing off in front of their friends. Their
trading accounts will suffer.
Trading mostly for the excitement or pleasure of the trade will not end well.
The other extreme in risk-taking behaviour is found in those people who take risk mostly for
the purpose of getting excited (or high, depending on your demographic). The sense of fear,
uncertainty, and insecurity felt at the time of waiting for the outcome of a trade (or the
outcome of a game in the casino) is addictive for some people. In this situation, trading is
their venue for seeking excitement, not a means to gaining financially. These people always
violate the most basic money management rules and there is no training in the world that
can make them better traders. Those who choose to go to a casino for this kind of excitement
at the cost of ruining their lives are known as compulsive gamblers. The best solution for
these individuals is to stop trading (and gambling) and seek medical and psychological help.
Retail traders are not properly informed by any stretch of the imagination.
Retail traders are lured to trading (well, mainstream media call that "investment") without
knowing what they are getting into. (Contrary to the fine print on the very complex brokerage
agreement they signed hastily to acknowledge that they know their risks and understand the
consequences.) Many people will say that it is these people's fault for not reading the
agreement and understanding the risk in the first place. But risk is such a complex thing when
it is related to trading. It is so hard to understand that brokers are required to pass several
exams before they can go out and solicit clients. Why, then, would anyone without prior
knowledge in finance think they can learn enough about the risk that they are going to take
by talking to these brokers for an hour or less?
Odds of Your Trading Account Being Ruined
Think of the game of roulette in a casino. It is well-known fact that, if a casino is operating
legally in the United States and in other well-regulated countries, then the casino is running
its business on a very small but well-defined edge over its gaming clients who play the game
of roulette. For most of the gamblers, the longer they stay at the casino and the longer they
play over their life time, the greater the likelihood that they are going to lose money at the

roulette table. This is how a casino makes its money — the aggregated result from all
gamblers will give the casino a net profit, by probability. In short, the odds favour the casino
right from the beginning.
So, if you like the excitement of uncertainty at the roulette table and play sensibly, meaning
that you only bet a small amount per game, then you will have a good time of riding the roller
coaster of winning some, losing some, and occasionally winning big. At the end of an exciting
week, you would probably end up not losing too much money and having a good time.
Using the word sensibly is old fashioned because it means that, if you do something that is not
sensible, you are an idiot. Well, the politically correct term nowadays is gaming responsibly.
I am not trying to be politically correct here, so if you do not like it, it is your problem.
In trading, a retail trader is facing a similar problem because the odds are not in his or her
favour right from the start. If the person trades sensibly, then the trading account would
likely enjoy a roller-coaster ride of account balance changes. By the time the person stops
trading, the account may end up with about the same amount of money that was put into the
account over all those years, minus commissions, service charges, and margin interest. This is
going to happen no matter how smart the retail trader thinks he or she is, how much trust
was placed in whichever guru he or she was following, or whatever random techniques were
being used.
Now some readers will figure out why I talked about roulette at the beginning of this section.
Gaming or trading sensibly is the keyword here that enables folks to keep most of their money
at the end of the game.
Any rush to bet in larger amounts, without proper consideration of risk, in the hope of a
bigger return, will put the trading account into a hole. The losses will not likely be repairable
over a long period of time, if they can be recovered at all. Doing something like that is
pushing your luck. Some people do get lucky a few times, but just like the roulette analogy,
as long as these people continue to play the market, these lucky winnings will be lost over
time.
Remember the pain tolerance level I mentioned in the last chapter?
Here is the universal version for net worth and account balance. Many people have a total
pain tolerance level of around 20% of their account balance or amount in total life savings.

Some people may have a higher tolerance but mild symptoms will still show starting at around
this 20% level. What it means is that once a critical blow to an account balance has reached
20%, most people will stop acting with reason. They will start to average down at all cost
(even if their normal selves do not do that), act numb to cut losses, and bet all they have in
the hope of a small gain.
Their animal instincts to survival are triggered but the response is all wrong because we are
not talking about a fight to the death situation here, and that financial matters do not work
the same way as a fight to the death scenario.
Unless the person fully develops a sense of capital preservation (or, well, is extremely lucky),
eventually, just one mistake in taking on risk (read a single trade) that is too much to handle
mentally by that person will wipe out all the profits this person ever made in his or her
lifetime.
It is extremely important to fully understand the risk you are taking. Think deeply of the
consequence of losing all the money you have. It could ruin your life and ruin your family, and
you could be devastated by the results for a long time.
Odds of a Retail Trader Being Able to Self-Correct
Most traders start out trading using charts, technical analysis, fundamental analysis, etc. —
whatever has been stuffed into their minds in the first place. It could be an article from the
Internet, reading books, or an introduction to an idea by friends. Eventually, however, it will
be the concepts that fit their perceptions of what a market is that will dominate their
decision making.
All these methods and tools give you a filtered view of the market. This filtering process is
like wearing a pair of coloured glasses. You will see whatever is not filtered away, which
helps you simplify the scenario so you can make a decision whether or not to enter a trade.
But that is not scientific at all, because choosing a method to study the price behaviour of a
market that has no objective quantification to determine its effectiveness is no different
from believing the moon is made of blue cheese. Retail traders are choosing a particular
method to trade in a market because that method makes them feel most comfortable, not
because it offers any form of profitability potential.
So how do traders advance beyond this stage of development in analytical skill? That depends

heavily on the person’s ability to self-correct. Self-correcting is the ability to sense problems
in the information gathered and proactively investigate the cause or origin of the problems,
resulting in a correction of the knowledge acquired.
For example, many avid readers are good at self-correcting when they read a line of text
from a book that causes them immediate confusion about what the text really means. They
will reread the text again several times, more carefully, in order to sort out its meaning.
Those who are able to apply their self-correcting ability to the information or knowledge
gathered about trading at this point in time will not only review the information gathered but
also will discard those materials that are irrelevant. These individuals are the ones who will
likely achieve some form of consistent success in trading.
Those people who are not able to apply their self-correcting ability to their acquired
knowledge, on the other hand, will be stuck in their development. As they seek more
information and techniques in trading to improve their poor performance, the pile up of these
techniques will cause ongoing problems in their analysis. There are two ways these individuals
can overcome this obstacle.
First, those who can make up their minds to completely discard the acquired knowledge and
start over again on a clean slate can make a breakthrough in applying their self-correcting
ability. Slowly, they will be able to find their way towards better consistency in trading.
Second, those who cannot see that the problem is nothing but themselves, yet understand
that it makes no sense to keep losing money trading the way they do, would be wise to seek
a mentor, a coach, etc. to help them correct their mistakes. Provided that a good mentor is
found and the mentor is compatible with the trader, the trader will have a good chance to
purge his or her mind of the useless ideas or concepts that have blocked him or her from
making better trading decisions.
Most of the time, however, it is simply a function of capital depletion that finishes off the
learning process. Running out of money to trade, because all the money available with which
to trade has been lost, will stop these people from trading, if not permanently then at least
for a long time. At least until they choose to come back to try their hand at trading again.
Odds of a Retail Trader Mastering the Art of Trading
Economics, which is the supposed study of economic activities, is not really a science. It is at

best a pseudo-science with no empirical significance. Trading, being called the very minute
details in the study of economics, are often labelled as a stochastic process (i.e., a fancy
term for something random and unpredictable). That means, trading and trading techniques
in general remain a magical skill and art form that cannot be fully described or explained.
Most people who master the skill learned from first-hand experience or learned from
observing someone else.
Like any other art form, trading skills take time to develop, and different people will require
different levels of training to enable them to trade better. Some people need a mentor, a
coach, or a trainer to help them improve their trading skills. Some people, who like a more
hands-on approach to learning, require a lot of painful experience before they can stop their
irrational decision-making behaviour from interfering their trading. And then there are others
who have difficulty understanding that trading is an art form, keep searching through the
historical data in the hopes of finding some illusive edge they can comfortably lean on.
Once traders can consistently profit from a market for a period of time, no matter if it is the
result of a lucky streak or hardworking efforts, they will have to face a completely new set of
challenges.
At the early stage of success, many traders would
• increase their position size blindly without careful consideration
• ruthlessly trade everything they can put their bets on
• act on the instrument they trade even though they do not know if the odds are in their
favour
All these actions indicate that traders have either run out of patience with the progress of
trading or have simply developed a sense of invincibility. This particular juncture in any
trader’s career is the most likely time period that ends it once and for all.
To build on their success, these traders should take it slowly and start to learn the more
complex concepts of money management, and how to apply their techniques to other trading
instruments in order to increase their trading opportunities. These types of changes to their
trading plans cannot be done hastily, because the negative consequences that could result
could mean an early termination of their trading careers.
Even top performing athletes do not start their careers with world-record performances. Most

of them are born with talents. But without proper training and experience in real
competitions, they could never reach their peak performances. So why would traders think
that they can make money in one of the most competitive markets right from the start,
knowing that they are competing for the same money that many world-class traders and
trading firms are going after?
~~~~
Beating the Odds
Here it is — the part that everyone wanted to know: the tips and techniques that can help
anyone beat the markets easily. Well, I am sorry to inform you that there are none in this
short eBook. Instead, I am going to introduce you to the foundations that are needed before
any retail trader can talk about real trading success.
Most of the books I have read on trading focus on winning strategies for some specific trading
instrument. Some talk about winning psychology. None of them talk about practical trading
success that is applicable to retail traders. That is the focus of this section.
Practical Success for Retail Traders
Let’s define what practical success in trading is. In short, it is something achievable for
normal people, not just for super-talented people. For example, in sports events, there can
be only one champion but there are also runner-ups. For sports like golf or for professional
poker tournaments, you have those players who have made it into the final cut off levels but
who never become the champion. These players are invisible most of the time to the general
public, even in national events. These players, however, are making decent money. For many
of them, it is an acceptable career .
If retail traders can consistently make money within their lifetimes and achieve consistent
profitability without exposing themselves to blow-up risks (well maybe in the beginning there
will be some blow-up risks because retail traders are not famous for having a lot of capital to
start with), then we can say that they have achieved practical success in trading. In fact, for
these people, trading is not glorious and it does not produce a lot of excitement; for them, it
is just a secondary income or career that helps them achieve the goal of financial freedom.
Not Everyone Has an Equal Start
Given the facts I stated in last section, the obvious conclusion is that any reasonably smart

person should walk away from trading because the odds of profiting from trading are so slim.
The real answer, however, is that it all depends on your situation.
If you have a high-paying job or career, then you have a choice of using trading as a tool to
gain financially on the side (or you can simply skip it all together should you be someone who
is extremely risk adverse). These individuals are the ones in a more favourable situation to
learn about trading since they do not need to worry as much about their income and can draw
from a reasonably large trading reserve as they go through the learning process.
On the other hand, if your job does not offer any hope of a better future for your or your
family, then trading can provide a potential gateway to a better financial future. These
individuals, however, will have a much more difficult time in starting their trading careers
because of the lack of trading capital and stable income. If you belong to this group, you have
to be very well equipped before attempting to trade.
The major difference of trading from a normal job is that it is scalable. What this means is
that the potential income that you can generate from trading is not limited by the labour
resources you have, that is, your time.
Consider comparing a dentist to a trader. Provided that they both are proficient with their
skills, a dentist can only earn as much as the billing allows for his or her time, while the
trader, given enough capital, can produce profits beyond what a dentist could ever imagine. A
dentist has the advantage of stability and better minimal expected return, and a trader has
the advantage of almost unlimited potential in maximum return.
It is very important to recognize the flip side of this argument: the dentist will still be able to
make a decent living with mediocre business skills while a trader, who fails to watch the risk,
will lose everything, and more.
Accepting the Fact That You are Fighting an Uphill Battle
By accepting the fact that the odds are totally piling up against you has many advantages.
Being able to visualize and feel in your mind just how dangerous this trading business can be
is even better, because that feeling of having a knife (or a gun) pressed into your back will
make sure you focus on the very basic survival techniques before your fancy thoughts of
success can even start to take shape.
This acceptance changes the attitude of most people from having a huge ego or being careless

to being a more careful person. It can help you to focus and really pay attention to learning
as much as you can before entering the arena of trading. Better yet, it will help you become
very efficient — things or ideas that produce negative effects on your trading will be more
easily discarded, as you know that these items will reduce your odds in surviving.
Have a Proper Battle Plan When You Fight a War
Everyone who wants to trade starts out with different circumstances. That’s why books
written on this subject never give out exact information on how you can proceed to learn
trading successfully. There are just too many variations and requirements to fit into one
book. This means that you have to write up your own plan on how you are going to approach
trading. In doing this, the more details you have, the better.
Remember that the goal is to achieve long-term practical success. Your planning must be
practical and suit your own situation; it should not try to meet some impractical goal of
pursuing your dreams. Big picture ideas are useless if the very basic requirement needed to
kick-start such ideas are not there in the first place.
To trade properly, you need seed capital. For a retail trader, the best scenario is that you
have so much money you do not need to work and you can burn through a lot of money
without feeling the pain. As most people do not belong to that category, it is better to secure
an income stream so that your living cost is taken care of.
If you have a decent paying job, then the planning should focus on picking markets and risk
levels that do not interfere with your job. It makes no sense to ditch your decent paying job
just because you are fed up with it. Not everyone has a higher calling to become a superstar
writer, actor, or trader with instant success. Even for the superstars, it takes some time for
the miracle to happen. Last time I checked, we need money to survive. So be sure to secure
enough money to live on, say, for a year or two, before even trying to place your first order
should you choose to quit your job.
Trading is not about glory. Trading is a means of earning a profit from a market. You can pick
any market that can give you an edge, or odds in favour of you to win. The last thing you
should do is to stick with markets that you are undercapitalized to trade in.
Back in the days when the original S&P 500 index future was traded at USD $500 a point,
there was an individual with a successful career in law practice who wanted to try his hand at

playing the index future. One of his clients, a veteran trader, gave the lawyer a sincere piece
of advice that he was not ready to trade S&P 500 index futures because the risk was not
something he could handle. Not believing that a simple number game could beat him, this
lawyer threw in $100K to open an account to make a point. He doubled his account within
several months by blindly betting on the direction of the open on the next trading day. He
was so proud of his achievement that he publicly humiliated his client during a social
gathering event. A year later, the lawyer blew his account, and everything he owned.
This lawyer had a winning streak but probability caught up with him. If he had focused on a
less risky market, or used a vehicle much less damaging, or just traded a single contract
without averaging down, the damage would have been a lot less and he would have survived
the learning experience with a lot less pain.
Patience Is a Virtue
Patience is one of the most important character trails found in many successful retail traders.
You may think that great traders are those who have explosive tempers, are quick talking,
and talk big all the time. That is simply a stereotype of traders working for trading firms.
Retail traders who achieve practical success in trading come in all sizes and forms, but one
quality that is very common among these individuals is their ability to wait patiently for the
right time to get something done.
Patience is a learned behaviour. It takes a lot of effort to train oneself to be patient in
dealing with different things. Sometimes people can be patient with one specific task (like
fishing), yet not be able to tolerate other common tasks (like lining up at a coffee shop). In
order to trade successfully, patience is necessary in many aspects of the process:
• to become proficient in the basics of trading
• to suppress the urge to make a trade when you have absolutely no idea what is going
on with the market
• to let probability work in your favour so that your trading capital can grow steadily
without exposing yourself to unnecessary risk
• to become adjusted mentally to handling more risk properly once you have stabilized
your trading performance over a period of time
Patience comes from a deep understanding of the issues you are facing. By understanding that

acting irrationally or impatiently will not improve your situation and will likely reduce your
odds in accomplishing whatever goal you have in mind, you will be able to improve your
patience slowly every time you successfully overcome your emotional urge to act (stupidly) on
a situation.
Equip Yourself with Knowledge on All Aspects Related to Trading
Many people who learn how to trade do not even know how to operate a computer. To
complicate the problem further, they rush to operate the trading software of their choice
without getting to know the platform first. Isn't it obvious that if something should go wrong
with their computer, which is very common, they will put their trading and their open
positions at risk?
There is no excuse to being technologically challenged. Being self-sufficient in using a
computer is almost a necessity. Being able to navigate through your trading platforms is
necessary before you can begin trading with that tool. Not educating yourself on how to use
the tools properly is just another way of saying you would like to lose more money in trading.
Another aspect of trading is its probabilistic nature. If you do not know anything about
statistics or probability, then go find some basic textbooks and learn about the subject. It is
one of the most important tools needed for trading and being ignorant about it can have
profound negative effects on your performance. A basic knowledge of the subject will go a
long way.
It is just as important to have reasonable knowledge of the instrument you are going to trade.
More than once I have seen beginners trading in commodity or index futures who do not know
that the contract they are trading is about to expire or has already expired. Assuming
everything is traded like stocks is asking for the markets to penalize you heavily.
Understanding the Importance of Capital Preservation
We have discussed various kinds of odds that can go against you in trading. The most common
element among them is the impact of trading losses. It is important to develop sound money
management habits and rules that you can stick to as early as possible.
Many traders choose to use 1% of their trading account size as the maximum risk that they are
going to take on a per trade basis. For example, if all you have in the trading account is
$10,000, then you risk no more than $100 per trade. The idea behind this concept is that if

the trading method in use has a long-term profitability bias, then at 1% losses per trade, the
trader will have the chance to take enough trades so that the statistical bias can work in his
or her favour.
That is not quite enough if a trader is just starting out. When someone is just learning how to
trade, it is not likely that he or she will have any winning strategies at all. Thus, the
probability that the trader is going to make money on the trading account is very low.
To make the problem more complicated, as mentioned before, many people will face some
kind of mental breakdown once 20% capital is lost. Thus, at 1% risk per trade, a beginner
trader does not really stand a chance of not blowing up the account once 20% of the account
is lost.
The better way to improve the odds for a beginner is to risk 1% (or, for those very confident
ones, 2%) of the 20% of the trading capital put into the account. Using the previous example,
if the trading account has $10,000 to start with, then $20 to $40 is the acceptable losses per
trade for the account. To be able to risk $100 per trade, at 2% risk of 20% of the account, the
beginning balance should start at about $25,000.
Beginners should also stop trading and re-evaluate their strategies or trading plan should a
drawdown of 20% or more be reached in a short period of time. That is a dangerous signal
telling them that there is something wrong with the way they trade and some adjustments to
their methodology or planning is needed.
Many people I talked to who asked for advice on account size requirements shot back at me
that such a risk-adverse recommendation is completely groundless and that I am effectively
telling them not to trade their favourite instruments. The truth is that they have a choice. If
their capital committed to trading is $10,000 only, then they can choose not to trade
something like e-mini S&P 500 index futures right from the start. They can start with mini-
sized forex, or ETFs with odd lots of 10 or 20 shares.
The important thing here is developing your trading skills and confidence, not to make money
right at the start. Even more important is not losing too much money before the necessary
skills are developed and have matured to the point where taking more of a risk is justified.
Some people insist on trading specific instruments for various reasons, yet they do not have
enough capital to trade safely. In this case using a trade simulator is highly recommended and

probably the only solution available at the moment to improve the odds. If traders are willing
to submerge themselves into simulated trading like a pilot being trained in a simulation
cockpit, they can improve their trading skills to the extent that it justifies using less capital
to trade when switching over to trading for real.
From time to time, we hear that a skillful and consistently profitable trader has blown up his
or her account. This happens especially during a time of changing volatility and overall
difficult economic conditions. Retail traders should learn to never take any single trading
position that has the risk of wiping them out. That means, no matter how likely you think
your trading position is going to make a killing for you, you should never bet the farm.
Proper position sizing is a science that requires a separate book to explain. For retail traders,
in general, it is best to not adjust position size until after a year of consistent profitability is
achieved. In order to let probability work in your favour, the mathematics tell us that you
have to keep the bet size, or in the case of trading, the risk size, the same for a prolonged
period of time in order to benefit from the statistical bias you are leaning on. Casually
increasing the risk you take on just because you doubled your account size by taking
outrageous risks is no different from betting on the roulette table over and over again with all
the winnings you have made so far. Probability will catch up with you sooner than you think.
Searching for Your Own Trading Style
Every trading methodology has its own weaknesses. A trader who has very short patience can
never trade successfully with methods that identify a long-term market bottom or top. A
trader with a small capital base cannot trade using a methodology that strives to benefit from
huge volatility.
Retail traders learn to trade mostly on their own. Thus, they have to teach themselves how to
trade even when they don’t know how to trade. Self-learning takes a lot of discipline to work.
In this area, individuals with a good scientific background will have an advantage over those
who have never been trained to do scientific research.
In short, to be able to teach yourself something you do not know, you need to explore (finding
facts and information), summarize (identifying key elements useful for your own purposes),
apply (using the information and collecting performance results), and evaluate (checking on
the performance objectively and looking for areas for improvement).

An interesting observation I have made is that certain traders, who either apply formulas or
rules without questioning those rules, or who routinely bend logic to fit their needs, fail
miserably in retail trading eventually. Traders who need to be correct all the time (i.e., the
“I am right” attitude) have very limited potential growth because they fail to see that the
goal in trading is to make money.
There Is No Need to Trade Full Time
If you are a retail trader who has not achieved steady success, trading income is the last thing
you can depend on to cover your living expenses. If your personality hates instability in your
income stream, then you should not seriously consider trading full time at all, even if that
idea pops into your mind. The feeling of uneasiness or insecurity you might feel when your
trading is not producing any income for, say, six months, will badly affect your ability to
continue trading.
As far as trading is concerned, I have seen no one, short of anyone undergoing a drastic
traumatic experience, who can change their basic characters to fit into the kind of trading
they cannot excel in. The basic character of individuals will dictate his or her thoughts once
they are put into a cornered situation. Trading with no income, or worse, with steady losses,
is a cornered situation for normal people.
There Are Times You Should Simply Stop Trading
Measured risk taking, with a reasonable plan to overcome the odds against your chances in
trading successfully, does not ensure that you will become successful in trading.
Other factors often come into play before you can get to the point where your trading is
stable and reasonably profitable. A sudden crisis in your life that is out of your control can
disrupt your schedule or take away from the time you need to put into trading. For example,
an accident that puts you into hospital for several months while you have open positions that
you cannot attend to, an unexpected divorce, or a sudden layoff from your job that had
provided the steady income needed. Things do happen.
When such unfortunate events happen, one must calm down and re-evaluate the viability of
continuing the learning path to trading. These events may set you back in terms of cash flow,
account balance, availability to trade, and so on. If you insist on continuing to trade, then
adjust your plan to handle the situation accordingly.

There are other minor incidents that can disrupt your focus, like getting sick or having too
much fun at a party the night before. If you know your brain is not functioning properly, walk
away from trading. You can turn off the monitors of the trading computer to avoid being
hooked by activity on the screens. You can work on the statistical bias of some trading
formations you have observed. Even a walk in the park is more productive than sitting in front
of the trading computer in the hope of fishing out something.
Remember, trading takes a lot of mental strength and having your mind in good shape is a
necessary condition for good results. It is best to stop trading, including flattening out all
open positions, when you are in a mentally distressed state.
Too Much Positive Thinking Is Hazardous to Your Bottom Line
I cannot recall when the movement of positive thinking started. Since then, many would-be
traders have taken the concept to the absurd extreme. They aim to eliminate their “negative
thoughts” so that they can achieve superior trading performance, or, magically, the market
will behave the way they want it to because their thoughts have enticed the market do so. To
me, this is just a classic example of wishful thinking and giving in to our basic desires over
using our logical minds.
In trading, there is absolutely no need to label the events that happen as good or bad. There
is no need to focus only on a good trading practice unless you are not sure what you are
doing. The ability to identify and feel something that is dangerous to you (such as knowing
that fire can burn you) is necessary to avoid being harmed. More importantly, you need to
know what has to be done when such adverse events happen.
Intentionally thinking of yourself as being a successful trader will not transform you into one
unless you put your mind and effort into getting there gradually with patience and thoughtful
planning. A well thought-out trading plan always has to include scenarios that are less
desirable because some “negative events” are bound to happen over the career of a trader,
no matter if it is a successful one or not. The prepared ones survive and move on while those
who are unprepared will be eliminated.
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Afterword
Know Thyself

While writing this short eBook, I kept asking myself the question, What can help a normal
person, who has neither prior experience nor training from the financial industry, achieve
practical success in trading (or investing)? I dug through my notes (yes, I am an old-style
academic type freak who kept notes on almost everything I have worked on) to see what
people asked about trading and how they tackled the problem by themselves. The answer to
my question and to many other questions, surprisingly, points to the everlasting words of the
Ancient Greek aphorism, Know Thyself.
Most of the obstacles faced by retail traders come from the lack of self-understanding. Some
people never think about who they are. Some are afraid to do so. Some just think that they
are invincible. Without knowing yourself better, how can you handle your deepest fear, which
can be triggered at the most unexpected time in trading?
Trading techniques learned from others can only produce short-term boosts to a person’s P/L
statement. They cannot remove the risk of ruin that the trader might fail to see or
understand. As a trader inside a firm, you have the edge of blowing up one of your firm’s
accounts and walking away with the potential of finding a new job. Sometimes a better job,
too. Retail traders, however, do not have this luxury and all they have are their own accounts
to blow up, plus they have to answer to every single consequence by themselves.
When you find yourself trading without a plan, without discipline, and letting your trades
affect you emotionally outside of trading, it is a very bad sign. If you failed to break out of
this downward spiral many times, you could be addicted to trading itself as oppose to use
trading as a way of making money. This can happen and is not something to be taken lightly.
Addiction is very difficult to deal with by yourself.The things you can do to help yourself -
close your trading account and seek for help.
Trading Skills Are Useful Outside of Trading
Traders sharpen their skillsover time in the ability to read the price actions, the patience to
find trading setups that provide good risk reward ratios, and the discipline to manage money
with the goal of capital preservation. These are all good principles and skills that can be
applied outside of pure trading in financial markets. Being able to apply these concepts
outside of trading can help a person to achieve success in other scalable ventures or business
decisions.

As a minimum, the skills learned from trading will help individuals be better at managing
their savings accumulated over their lifetimes.
Hence, I always encourage people to learn something about trading and, if possible, to try
their hand at using the trading simulators that are available on many major financial and
brokerage websites. Becoming involved in trading by going through the learning process and
by learning to understand yourself is an experience that fosters useful skills with lifelong
benefits.
Besides this advice, I think having a good laugh at the financial news every day and trying to
find reasons that explain the market’s activities is priceless. The one thing you learn from
trading is that all these explanations have absolutely no connection to whatever actually
happens.
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Resources for Aspiring Traders
Until I have the following eBooks completed, I am making the chapters already written
available online at my website
First one is Crash Course on Chart Reading.
The other one is Defensive Money Management Explained.
There are two online charting sites that provide excellent charting tools.
First is Yahoo Finance, />Second one is BigCharts.com, />For those who need help in dealing with their trading addiction, there are very limited online
resources available. It is expected because no one really benefit financially from telling
people to stop trading. Here is a good starting point from Dr. Brett Steenbarger,
/>~~~~
Acknowledgements
Thanks to my colleagues at TickQuest Inc. () whose support
allowed me to devote some of my time to working on this eBook and to working on several
other projects without worrying about the daily operations of the company.
Second edition is made possible with help from Beth McAuley().
Her excellent work has transformed this eBook into something enjoyable to read.
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